I can’t believe it has been almost four years since my first “how financial institutions make money” post. Crazy how fast things go by so quickly. This initial post continues to be one of my most active even today and the primary path that people come to this post is through Google. It’s interesting that so many people are simply Googling (love that this is now a verb) the question: How do financial institutions make money? Honestly, I believe many people are pretty fed up with how things have been going financially and yet the Big Three (IRS, Wall Street, Banks) keep making money hand-over-fist.

For the most part, people are finally seeking to educate themselves first before just following another opinion. Opinions drive me crazy. I’m mean, I certainly like mine but who cares other than me, right? Mint Chocolate Chip is the BEST ice cream flavor of all time. No Kelly, says you, “_____ is the best ice cream flavor!” Who’s right? Who cares? Seriously, no matter what you say I still love Mint Chocolate Chip.

When it comes to the title of this blog “How financial institutions make money” there are no opinions. There’s only truth and the truth could care less about opinions. All of us must understand that there are four rules which are deeply cherished by the IRS, Wall Street and Banks. These rules allow all three to work together. They allow all three to ensure that they’re winning. They allow all three to redirect the risk of success entirely upon you. I thought we’d review these four rules today. You’ll find that they are extremely simple but they have huge implications. It’s interesting to me that even the Bible talks of a cord of three strands being unbreakable…these three (IRS, Wall Street and Banks – from now on referred to as “IWB”) are most certainly intertwined together and are so hard, if not impossible, to break.

Rule #1: They want and need your money

Now, before you pass this one off as too simple to carry any weight then please take a moment to think about the importance of this one (it’s #1 for a reason). This one does not require much explanation. All three, IWB, want our money and need our money in order to both operate and turn a profit.

Rule #2: They want and need your money on an ongoing basis

What would happen to Walmart, Coca Cola, Pepsi, McDonalds, Budweiser or any other company in the country if beginning today every customer only bought their product(s) one more time? That’s it. Just one more purchase. They would obviously have a HUGE day if every customer placed their order today but come tomorrow the alarms would be blaring. Nobody shows up again and these businesses are out of business very quickly. Think of all of the employees that would be unemployed or all the buildings that would be vacant or all the farmers who would have no one to sell their produce to…the results would be devastating and felt by all.

Is this example any different for the IWB? No. They must have your money and they must have it on an ongoing basis. If they don’t succeed at this very simple truth then they fail as well. Now, we could dig in real deep to show how, unlike the above mentioned companies, it is virtually impossible for them to fail. They can’t. They won’t. If they actually do fail then along comes Joe Taxpayer to bail them out so that they don’t fail. No matter what happens, they get our money on an ongoing basis.

So how do they accomplish Rule #2? They create financial products that we buy and that we “need”. Banks offer checking and savings accounts, CDs, money markets, loans, credit cards, etc. Wall Street offers financial investment accounts that we contribute to and hopefully grow and the IRS controls the tax implications and the rules behind all of it.

Rule #3: They want and need to hang on to your money for as long as they can

Does the bank like it when you withdraw your money? Of course they don’t. Keep in mind; their liabilities are their greatest assets. Your money on deposit with them is a liability to the bank – they owe you that money at a promised interest rate; however, they’re turning that money over and lending it to others at a higher rate. We must understand that there is a difference between liabilities and debt. Debt is no good and we must get rid of it but liabilities when managed properly can create a bunch of wealth for us just as they do for the banks. What happens if everyone goes to the bank the same day to withdraw their funds? It’s called a “run on the bank” and the bank would have to shut their doors or be faced with bankruptcy. They are never in a position to get everyone their deposits back on any given day because they don’t have it. They need our money, they need it on an ongoing basis and they need to hold on to it as long as possible.

The government is the worse with Rule #3. Why do they have so many rules when it comes to you using (whether you simply need it or just want it) your funds in your qualified plan accounts (IRAs, Roths, 401ks, etc.)? First, let’s make sure we get something very clear here – any funds in your government, qualified plans are not your funds. The government owns and controls that entire transaction. If it is truly your money then why are there so many rules around accessing the funds? Why do you have to wait until you’re 59 ½ to touch it without penalty? What if you choose to retire at age 50? If these accounts are truly in your best interest then why is there any penalty at all? Why are you required to take money out if you hit 70 ½ (Required Minimum Distribution)? What if it doesn’t fit your plan or it’s not in your best interest to access those funds at that point? The number of rules and regulations on these accounts are insane. You have NO control over them ultimately. Plus, the government can change the rules at any point to serve their financial needs. So, the IRS loves Rule #3. The banks love it as well. Wall Street makes a killing off of it too because they get to manage the money within these products. Think about it: you’re 35 years old with an IRA and you can’t touch it without penalty for 24 more years! Wall Street has a client for a LONG time!

They want to hang on to your money as long as they can and the rules and the product design allow them to do so.

Rule #4: They want and need to give your money back to you as slowly as possible

This one is similar to Rule #3 but it has a slight twist. They want to hold on to our money for as long as possible therefore they create rules to give it back to us as slowly as possible. If this isn’t the case then please explain the 10% tax penalty for withdrawing funds from a qualified plan retirement account prior to being 59 ½ years old. It’s your money (after all, you’re the one who made the deposits) so why are there so many rules and why are there penalties for you if you choose to access your funds? Answer: Rule #4. The government does not want you to be in a position of control because that takes away from their control so they create rules. These rules are based around them maintaining control so they limit your access. What’s shocking is that people continue to fund these accounts. Wall Street loves it because it creates a great deal of job security because they know you won’t access this money due to the rules and penalties so they have your money under management for many many years. The banks love it too because you’re not in a position to access capital for large capital purchases so they offer you a loan…and we know how much banks love that one.

These four rules are always at the center. When you begin to plan your trek up the mountain of retirement planning you can always find these four rules working against you…if you just pay attention.

Mt. Everest – descending is the most dangerous

Are there options? Are there ways to minimize the effect of these four and create a more effective plan up the mountain? Yes there are. Remember, for those who die climbing Mt. Everest, 70% of them die on the way down. The descent is the very most dangerous part of that journey. It’s no different financially. People are just climbing up without an understanding of how these rules affect them and more importantly, how they affect them on the way down. What do I mean by that statement? Well, if you have a large sum in your qualified retirement account, or that’s your plan at least, then please tell me the tax implications on that money during your retirement? You don’t know. No one does…it’s impossible because you’d have to literally know the future. You see, any financial professional can only plan one year at a time with those types of accounts because we don’t even know what taxes will be or what the distribution rules will be for next year. If you’re in this position then you can truly only plan one year at a time and that’s a very dangerous position to be in. The descent will most likely not work out in your favor. You must not only plan to effectively get up the mountain top but also to get back down to base camp alive (i.e. be financially independent through your life expectancy). With this knowledge your trek up the mountain may take a different path and while others are falling off you’re holding on just fine. That’s our expertise. That’s what we do for our clients.

There are solutions. There are answers to minimize the Four Rules’ overall negative effect on your plan; however, you have to be willing to learn. I don’t care what financial position you’re in, you must be willing to have a few discussions with a student-type mentality.

“A large down-payment will save you more money on your mortgage over time than a small down-payment.”

This one is long…most likely will be the longest in this series but it’s worth it. This topic cannot be “glossed” over if a paradigm shift in your thinking is to occur. I heard recently,

“Have you probed your paradigm lately?”

Thought that was funny and yet so great of a question. Let’s face it, even the Bible tells us to ensure those who teach the Word are in fact teaching accurately…basically, don’t take anyone’s word for it. We have to stay diligent in our learning or we can simply become dead in our thinking. Or worse yet, a blind follower of that which is not true. Case in point here with Dave’s mortgage advice.

YOU OR THE BANK

In the previous post, we discussed a basic financial truth: you finance EVERYTHING you buy. This happens because you either keep your cash and borrow thus paying interest (finance) or you use your cash to purchase (Dave Ramsey’s method) and thereby lose interest you could have earned on that money going forward (lost opportunity costs – aka a finance expense).

So it begs the following two questions:

Which of these two situations will cause the least amount of wealth transfer for you personally?

Which option makes the most money for the bank?

I’ve yet to meet an individual who intentionally desires to transfer large amounts of money away. Also, I do not know one single person who wishes to make financial decisions that benefit the bank the most. Unfortunately, very smart and well-minded individuals do this everyday…and the mortgage is just the tip of the iceberg.

So, will a large down-payment save you more money on your mortgage over time than a small down-payment?

Yes or No?

ROCKY ROAD ICE CREAM and INSULIN

If you said “Yes”…you’re wrong. Remember, it’s NOT my opinion but rather it’s the MATH that proves it wrong. Unfortunately, Dave Ramsey’s advice, compared to that which is mathematically true, is similar to the comparison of Rocky Road Ice Cream and Insulin.

Dave is saying that Rocky Road Ice Cream is the best (Subjective Opinion – you see, I think Mint Chocolate Chip is the best) yet he’s presenting it as an Objective Truth. His teaching on this (make a large down payment to save you money) is only backed up by his personal attitude and feelings. It’s like Dave saying that Rocky Road Ice Cream is medicine to help the diabetic. That’s just false. Insulin is the medicine that helps the diabetic (Objective Truth – doesn’t matter if you like it or not).

When we present our opinion as an objective truth we set ourselves up to be proven wrong…that’s what Dave has done.

Dave can claim all day that the above statement from our quiz is True but it’s not. He’s giving you ice cream to heal your diabetes (your financial plan). We give you Insulin.

So, if something you thought to be true turned out not to be, when would you want to know about it?

Right away!

If you believe that a large down-payment saves you money then logic would follow that you feel the best down-payment is paying cash in order to pay no interest on a mortgage. So, if “cash” is the best down-payment, then let’s take a look.

EQUITY HAS NO RATE-OF-RETURN

First, you have to understand that equity has no rate-of-return. A down-payment, or paying cash for a home, is like putting money in a tin can and burying it in the back yard. The day you sell the home you get to dig the can up and blow off the dust. Since a home appreciates or depreciates the same if it is financed 100% or is free-and-clear, makes the cost of having our money tied up in the house something we should consider.

As a matter of fact, every dollar you pay to equity actually decreases in value each year due to inflation. If you put $10,000 towards your equity this year that same $10,000 is available to you in the future (assuming of course the bank allowed you access or you sold the home), but, at that future date it has less buying power because of the inflation factor. Yes your home may have appreciated but it would have appreciated anyway whether you put the extra $10,000 towards equity or not. Now, most “wise” mortgage Ramsey followers will say “No, what I pay in principle DOES have a return because I’m paying less in interest.” Not so fast. Keep reading.

$31,693,128…now that’s a MISTAKE Dave!

Recently, some news came out about Dave Ramsey’s new house. I contacted Peter who heads up the blog I read about Ramsey (and just linked to) and I sent him a quick video on the math for Dave’s very own purchase. This video is personalized for Peter but go ahead and take a look of Dave’s HUGE mistake. If you recall earlier, in my first mortgage post…this is where you either start to get a bigger box or you choose to keep following an opinion because it “feels” good.

Banks aren’t in the business to make me “feel good”. They’re in the business to make money from my money…period!

Let’s recap the video:

Dave has $4.9 million to buy his home. He decides to pay cash. What Dave must understand is that it costs him the same amount of money to live in the home whether he finances it or not. How’s that possible? Well, with math…that’s the whole point. Remember, this is Insulin not Rocky Road Ice Cream.

If he could have invested that $4.9 million at 5% he would have a balance of $21,891,947 after 30 years. If he financed $4.9 million at 5% he’d have a monthly payment of $26,304. If that $26,304 is going to the bank and not being invested at 5% then the principle and interest PLUS the lost opportunity costs (not able to invest those payments if they’re going to the mortgage) equal $21,891,947. They are identical.

Now, you Ramsey followers are told, and very foolishly by the way, that if you put your money in a “good growth mutual fund” you can average 8-12%.

Unfortunately, his position here is even wrong because the average rate-of-return means nothing…only the actual rate-of-return is what you should concern yourself with regarding your money. Watch this video of us explaining this very thing.

So, if Dave took his own advice, because he certainly claims that over the “long haul” you can in fact average 8-12% so it would only make sense that he could also, then his $4.9 million could have been invested at these rates. Let’s take the 8% and be nice (keep in mind, you have to take the Expense Ratio and 12b1 fees into this as well so you can typically add another 1 -1.25% on top of this “average”). If he invested the $4.9 at 8% in 30 years his account would be $53,585,075.

Wait, you mean, if he took a mortgage at 5% it would cost him $21,891,947 (far more that what he even claims because he only takes the principle and interest into consideration we add the lost opportunity costs because let’s face it, he’s making a mortgage payment and that payment can’t be saved anymore) and if he took his own investing advice that $4.9 million could become $53,585,075? Yep. Ummm…that’s a $31,693,128 difference! No small change here folks.

If he can’t sell that home in 30 years for $53,585,000 then Dave Ramsey made a minor financial error. But there’s more.

BEGS THE QUESTION DAVE!

A lady on the blog I mentioned above made this comment to me,

“But Kelly you are not taking the risk factor into this. He could lose everything.” (not an exact quote)

She’s right; however, does Dave ever say that statement concerning his recommendations? Does he ever say that if you invest in a “good growth mutual fund” that has a track record of at least five years that you could lose everything? Nope. As a matter of fact, all of his calculations assume that the 10-12% WILL in fact happen (by the way, feel free to send me any mutual fund that you think would make Dave happy and I’ll break down the ACTUAL rate-of-return for you).

Take me up on that last offer!

Even though he believes that it WILL happen, let’s say that he could in fact lose everything (which he can) and chose to NOT take on the risk to ensure he wasn’t under risk of foreclosure if the “Fit-Hit-The-Shan”. Let’s break it down.

“You’ve compared a zero risk investment [free and clear home] with a risk investment [investing in mutual funds] , and you don’t do that.”

He’s right but that does beg the question: Dave, can we take a zero risk investment with a zero risk investment? Maybe we’d want to do that if we could.

What would it look like, assuming he decides to go with his own recommendation here and take no risk, if he chose something that has guarantees at a measly 5%? Remember, this account CANNOT lose so it’s an absolute certainty that the 5% will happen. Well, we’ve already proved earlier that investing the lump sum at 5% and paying a mortgage at 5% would come out the same. So what are we missing?

Any guesses? His tax deduction. You see, this new home of his is a primary residence. Let’s be nice and say he’s at a 35% tax bracket. This changes his GROSS rate of 5% to a NET rate of 3.25% after the tax break. Now, once we consider the mortgage payments at 3.25% that we can’t invest since they’re going to the bank (again, opportunity costs), it’s costing him $12,973,610…no longer the $21 million figure.

His puny, wimpy, guaranteed account earned him $21,891,947 and his mortgage cost him $12,973,610. A difference of $8,918,337! With how much risk? COME ON, with how much risk!?

NONE! It was all guaranteed.

Who had control of the money? HE DID!

What happens if values plummet? THE BANK FREAKS OUT NOT DAVE!

What happens if his income stream completely dries up? HE’S LIQUID!

Dave’s all about emergency funds so what happens in case of emergency? HE HAS THE MONEY NOT THE BANK!

What happens if he comes across an investment opportunity? HE HAS LIQUIDITY AS OPPOSED TO EQUITY!

Here’s two bonus questions:

What if the account where he has this money has no penalties to access?

What if this account can be used later tax-free?

Answer me this: do you think that banks have a faulty model of making money?

I mean that seriously. Do you? Can you literally “look me in the eye” and say that the way banks make money is ineffective?

Of course you can’t. Yet you then discredit the same model when it’s presented on a personal level. Maybe not you…but Dave sure does! You see, in this example Dave did exactly what a bank does:

He borrowed money with a low cost (3.25%). (He’s all about getting a deal)

He used his money in a guaranteed and predictable environment (at 5%) to earn a spread. (Remember, he said no risk)

His mortgage is fixed so it will NEVER go up or cost him more and

His earnings are FIXED because it’s in a guaranteed environment.

No matter what happens he wins. He created a banking environment for himself because both of these two financial tools were guaranteed to happen.

REMEMBER…YOU’RE A FINANCIAL IDIOT!

You see, I just about exploded when Dave’s right-hand man (I won’t use his name or title because he is an old friend of mine from church), told me (after seeing this math for himself) that “80% of our clients Kelly are financial idiots”. Honestly, that pissed me off…in a big way. I asked him, “Then why are you following his advice?” He had no answer.

You’re not idiots. You’re just being served Rocky Road Ice Cream for your diabetes. It’s time for some Insulin.

Next up, the math behind his bogus advice about 15-year mortgages versus 30-year mortgages. The banks would love for you to choose a 15-year mortgage…that’s the problem!

I’ve spent some time over the last few posts about, what we call, Defining Moment #1. This post dicusses Defining Moment #2 but lets first start with a quote from the former Comptroller General of the United States, David Walker:

“We are heading for a future where we will have to double federal taxes or cut federal spending by 60%”.

The rapidly changing demographics of our country are going to impact everyone’s lives in our nation. Simply believing we are a great nation will not continue to make us one. To compete and survive we will have to change and that change may not come easy.

Alan Greenspansaid “As a nation we have already made promises to coming generations of retirees that we will be unable to fulfill.” Keep in mind, he said this in 2004…well before the last two years of continued spending.

That’s why Defining Moment #2 is critical to understand, it states that “this may be the lowest tax bracket you will ever be in.”

As you are reading this post, the U.S. Federal Government continues to spend more than it takes in from tax revenues. The debt in our nation is growing over one million dollars an hour. And it keeps going up. What does that mean to every person in the United States? Well, in order to pay for this government burden every citizen in the country would have to pay about $174,000 or for every household $664,000 (as of September 2010).

The purpose of telling you this is not to scare you but rather to make you aware that all the conditions are in place for everyone’s taxes to increase. We know this isn’t new information for you but you can’t just take this for granted. You must understand the importance of planning for not only the demographic changes but the serious problem our government has created for itself and exactly what it means to you.

Traditional thinking professionals may be willing to avoid this problem that is out there right now until it becomes a crisis for you. For example, are you still being told to defer your taxes now by contributing to a qualified plan that will be most assuredly taxed at a higher rate later? Times are changing and if you’re being told to just wait it out and see what happens, it is simply going to be too late to react to the problem.

Future taxes that you pay will be the largest transfers of your money that you will ever make. The size and amount of future taxes has not yet been determined but we do know that government debt will be a large determining factor.

You must not only understand this Defining Moment that this may be the lowest tax bracket you will ever be in but you also need to act upon that knowledge.

What if you in fact could be insulated against future tax increases and use your money tax free when you need it? Would it make sense for you to do a little homework for yourself? Truly, how much is that worth to you?

If you don’t have a plan to counter this defining moment then please understand, the government does.

We’ll continue to do our part in providing you as much free information and analysis as you need. But, you need to step up to the plate and ask some questions.

We just discussed how this first Defining Moment, that your money will never be worth more than it is today, motivates banks and why they live by it, but how does it impact your mortgage?

If you own a home and have a mortgage on it you are probably the proud recipient of a lot of junk mail. Much of this mail is from financial institutions who want to inform you that making additional payments on your mortgage is a good thing. For whom it is a good thing is not clear to most but for those who understand this Defining Moment it’s very clear.

We touched on this a little bit before but let’s take it a little deeper. Let’s start with this question: would you like to make more house payments now with dollars that will never be worth more than they are today? Or, make more payments later when the buying power of that money is far less?

Let’s look at some math. If your mortgage payment is $1,000 per month, do you want to make more payments now when your money has the buying power of $1,000 or make more payments later when the buying power of that money is $412 thirty years from now? (Which is the buying power of $1,000 with a 3% inflation rate for 30 years).

What you need to understand is that the value of your home is going to go up or down no matter what your monthly payment is as well as no matter what your mortgage balance is at the time.

To prove that point, if there are two identical homes side by side and one is paid for but the other is mortgaged, at any point, the houses are worth the same. Neither the payment nor the mortgage have any effect on the value of the property.

But by making additional payments or paying cash up front for the house, you have used the most expensive buying power dollars you could to do this. At the same time by using today’s money to make additional payments you have made the banks and mortgage companies very happy. Remember they are in a win-win situation. So what do you do?

We’d highly recommend you read our Mortgage blogs when they’re posted…so that means you’d have to subscribe. There is one thing I know that WE can do for you right now.

We can prove, again not with concept or fancy theory but good ‘ol 8th grade math, that paying extra and sending more of your most value dollars to the bank ahead of schedule actually hurts you financially.

Big paradigm shift, we get it. Call us crazy but we also can prove that a 30 year mortgage can actually pay off FASTER than a 15 year mortgage using the exact same budget for both…even with a higher interest rate on the 30 year. Read that again. This can be proven with math and no investments are needed to accomplish this fact. It’s true and can be backed up with simple math.

So, we’ll do our part for free by showing you. You just have to challenge us and be willing to learn something new.

We hear every day, “I thought that I should pay extra principle to lower my interest expense?”

First, the banks are in a win-win situation no matter what you do. You see, if you don’t make additional payments because you understand that you are giving the bank control of more money, then they will just collect more interest over time.

If you do make additional payments the bank doesn’t just sit on it. Remember, they’ve mastered Defining Moment #1 and the velocity of money. That additional money from you is used and lent back out to start the process all over again.

What would you rather do, follow traditional planning and make all attempts to have your $10 earn $1 more? Keep in mind, you have to deal with all the other flexible factors that we discuss in our Why Traditional Planning Fails To Reach Its Goals (future posts). Or, function more like a bank and have your $10 do the work of $50?

Yeah, I think the bank model works quite well. So what do we do? Well, here’s an important question: do you believe banks have your best interests at heart? Most people say no. If you said “no”, then have you ever asked yourself why banks offer a lower rate on a 15 year mortgage than a 30 year? If they don’t have your best interest at heart and they are giving you an incentive to go with a particular product, then maybe we should do a little math.

They understand perfectly AND IMPLEMENT the Defining Moment that money will never be worth more than it is today? They want as much of your money as soon as possible (ie a 15 year mortgage) in order to keep it moving, working, and earning for them.

They’ll even entice us by offering gifts for our deposits and they promote like crazy just how convenient it is to deposit our money. You’ve seen the recent TVcommercials about the new technology for ATM deposits. Isn’t it ironic that they also make us rely on credit scores which are a directly determined by just how quickly we pay them back?

If we apply this defining moment to our everyday lives the lesson becomes more and more apparent. By taking a look at the country’s savings rate, there’s no doubt that our ability to hang on to today’s money, the money that has the most buying power, is dwindling.

In reality more of our dollars are going to someone else in the form of debt payments, taxes, and other financial transfers more than it’s working for us. The ability for Americans to save “today’s” dollars has all but diminished.

The traditional approach must change, and the sooner the better. What is really needed is more financial literacy. It is so important to understand that “your money will never be worth more than it is today.” And equally important, how it may impact your thought process in your everyday life.

If you do, then maybe you’ll question the various strategies recommended to give your money as soon as possible to other entities. Even if it means incurring some more interest expense.

Do you remember the scene in the movie “Miracle” about the 1980 Olympic Hockey Team when coach Herb Brooks told the young men that today was NOT going to be the day that the Russian team would win? It was a defining moment for that team. Well, we talk about financial Defining Moments.

I don’t care how successful you are, if you do not understand how these financial Defining Moments effect you as you accumulate, preserve, and certainly as you distribute your wealth…well, then today they’ll probably beat you.

Defining Moment #1 is, “your money will never be worth more than it is today.” That sounds really simple and if you think about it, you’ll agree that EVERY financial institution masters this one lesson. Because of this, they also understand the phrase “the velocity of money.”

Money that doesn’t move or have velocity is like money that is stuffed in a mattress; it doesn’t create wealth or profits. To give you an example, the average bank in the United States spends a dollar about five and a half times. Have you ever thought how they do that?

Wouldn’t you love to spend YOUR dollar 5 ½ times? Well, it’s simple. First they TOTALLY embrace this Defining Moment. You see, they take money, and it is not even their money, that is deposited in their bank and lend it to other people.

These people who borrowed the money make payments back to the bank and pay interest. The bank then takes those monthly payments and lends that money out again, over and over. This process continues repetitively about five times on each dollar they touch.

The collection of interest alone is very profitable for the bank. But they understand one rule that creates more profit for them than just collecting interest. They understand that MONEY WILL NEVER BE WORTH MORE THAN IT IS TODAY.

Due to inflation the buying power of a dollar decreases over time. The buying power of $1,000 today with a 3% inflation factor built in will have the buying power of only $412 in 30 years. The banks and lending institutions understand this clearly and they may even encourage you to make additional monthly payments on the money they lent you.

Wait a minute Kelly, I thought that I should pay extra to lower my interest expense?

Well, if you understand and, more importantly, apply Defining Moment #1, then maybe you should ask some questions.

A modified what? It’s called a Modified Endowment Contract (MEC) and was a creation of the terrible twins TAMRA (Technical And Miscellaneous Revenue Act of 1988) and DEFRA (Deficit Reduction Act of 1984).

It’s important you understand why the MEC was created, who created it, and how it can effect your money. IRS Code, Title 26, Subtitle F, Chapter 79, Section 7720 is the description. If you’re bored feel free to read it. Here’s the point. The very fact they, the government, made the effort to craft and pass this type of restriction and limitation on what you could do with your money, keep in mind, it wasn’t like this prior to 1988, tells us one thing: it must be good in regards to taxation.

You see, prior to 1988 you could put virtually an unlimited amount of money into cash value life insurance and get all the benefits. What benefits? Here’s a list:

money grows tax deferred,

can be used tax free,

has a competitve rate-of-return (remember no fees and no tax),

has guarantees,

returns a tax-free dividend based upon company performance,

the money is credit proof,

you could contribute an unlimited amount of money,

you were unlimited in your investment options because you had

liquidity, use and control of the money,

it could be used as collateral,

it was estate tax-free, and

had disability protection – meaning if you became disabled the insurance company would continue to contribute your annual outlay (what 401k will do that one?).

Take a look at this pdf and line up the benefits you have with your money compared to how these policies are designed…click here.

The government didn’t like this; therefore, they decided to “further limit the perceived abuses by preventing policyholders from paying large single premiums to purchase life insurance and borrowing the cash value, tax-free.” Heaven forbid we have some financial tools that they don’t have their hands ALL over. The founding fathers of this country would be up-in-arms. Folks, this type of policy, and the benefits associated with it, had been a LONG standing tool used by virtually all the wealthy families in the country…here’s a great book that describes this very thing, The Pirates of Manhattan. I have no association with this book it’s just a good read. Check this out, this is an article from November of 1999 in the Denver Business Journal. They did a special publication called The Century Book. This publication dedicated one page for every year from 1900 to 1999 and covered something from Denver’s history for each year. For the 1929 page they talked about the Crash and introduced you to Claude Boettcher – “Denver’s most famous investor”. Anyone who has lived in Colorado for any length of time has heard of the Boettcher family. This article mentions how he lost everything but waited for banks and stocks to drop so low that he borrowed $2,000,000 from his cash value life insurance to buy them all up (notice he lost his investments but he didn’t lose his insurance values). I love the line right after the mention of this – “the reason he is still known to history. Most investors had no other resources to call on.” Read it here. The “Infinite Banking Concept” is NOT NEW! It has been around for over a century.

In 1988, the government created a limit. So think about this: who determines the minimum one can pay for a death benefit of, let’s say $500,000? Come on, who determines the minimum you, the consumer, can pay for a death benefit of half a million? The insurance company. They decide what they can charge you and still make a profit. This is called term insurance. You pay the least amount and get one benefit – death benefit. On the other side of the spectrum, who determines the MOST you can pay for that same $500,000 death benefit? Most people say, “I do. I determine the most I’m willing to pay.” Wrong. The government. The very fact that the government limits what you are able to do with your money tells you that it must be good in regards to taxes. You know what, they’re right. Of course they’re right. Taxes are their biggest concern. If they aren’t getting them then you bet your $SS they’ll go out and find them.

It then begs the question as to why whole life insurance policies are still around then, right? Well, you can still get all the above benefits, EVERY one of them, you just have to now capitalize the policy a little slower. Before 1988, you could put, for example, $200,000 as a lump sum into a policy and get all the benefits. Today, you have to spread that out over, typically, a five to seven year period. The argument of “cash value life insurance is too expensive” is plain elementary. Those supposed experts who make that claim are right if someone is using CVLI purely for protection…i.e., focused on one benefit. Buy term and do something with the rest. However, if you want to act and function just like a bank then you’d pay the most amount of money for the smallest death benefit to dance just below the MEC line and get ALL the benefits above on your money. Read that sentence again. Around year five you’d have available every single dollar you put in. This then becomes a pool of money that you can use to replace any financing or lost opportunity for paying cash. It’s exactly what banks do. Take a look at this graph (it’s nothing fancy as I created it, but the data is straight from the FDIC website). I broke down the top five banks and their holdings in cash value life insurance, in the BILLIONS, and more importantly, how they have increased their holdings over the past few years.

JPMorgan Chase is the only one who’s values went down between 2008 and 2009; however, their loan balances went up by almost the exact same amount. They very well likely utilized this powerful tool to borrow from. We’ll know at the end of this year when we see their numbers. Folks, these are the top five banks in the country making double digit percentage increases in their cash value holdings! Why? Because they are masters of liquidity, use and control, and leverage. I ask you, are you?